“Wealth effects of bank mergers in India: a study of impact on share prices, volatility and liquidity” Muneesh Kumar AUTHORS Shalini Kumar Florent Deisting Muneesh Kumar, Shalini Kumar and Florent Deisting (2013). Wealth effects of ARTICLE INFO bank mergers in India: a study of impact on share prices, volatility and liquidity. Banks and Bank Systems, 8(1) RELEASED ON Tuesday, 30 April 2013 JOURNAL "Banks and Bank Systems" FOUNDER LLC “Consulting Publishing Company “Business Perspectives” NUMBER OF REFERENCES NUMBER OF FIGURES NUMBER OF TABLES 0 0 0 © The author(s) 2021. This publication is an open access article. businessperspectives.org Banks and Bank Systems, Volume 8, Issue 1, 2013 Muneesh Kumar (India), Shalini Kumar (India), Florent Deisting(France) Wealth effects of bank mergers in India: a study of impact on share prices, volatility and liquidity Abstract Mergers have the potential of possible value creation for various stakeholders, which in turn may affect their wealth. The wealth effect of merger may be noticed right from the time when the merger is announced, as share market would, generally react to such announcement affecting the stock characteristics of the company. The impact of such reaction has been a matter of concern and confusion particularly from the perspective of shareholder’s of bidder banks. The market reaction to merger announcement has primarily been examined in terms of impact on stock returns and very little attention has been paid to other stock characteristics. This paper examines the impact of merger announcements in Indian banking sector on shareholder’s wealth, focusing on three stock characteristics namely, stock returns, volatility and liquidity of the bidder banks. It is assumed that volatility and liquidity also influence value for the shareholder’s wealth. The paper is based on the study of market reaction of merger announcements in Indian banking since 1999. It was found that the merger announcement had a mixed impact on the returns to the shareholders of the bidder banks. As far as other stock characteristics are concerned, there was limited impact of merger announcement on volatility in share prices of the bidder banks and no significant impact on the liquidity of the shares of bidder banks. Keywords: merger, merger announcement, market reaction, stock characteristics, pre-announcement period, post- announcement period, bidder banks, target banks, returns, volatility, liquidity. JEL Classification: G21, D4. Introduction the target bank may gain from the merger as the premium offered to induce acceptance of the merger Over the last two decades, the banking and financial offers much more price than the book value of the services industry has experienced profound shares. Similarly, shareholders of the bidder bank changes. One of the most important effects of this may gain in the long run with the growth of the restructuring process has been an increase in con- company not only due to economies of scale but solidation activity (Cybo-Ottone & Murgia, 2000). also due to other factors. It will be interesting to Globally, mergers and acquisitions (M&A’s) have examine as to how the market players view these become a prominent strategic alternative for corpo- potential gains and reacts to merger announcement. rate restructuring, and the financial service industry Mergers result in overall benefits when the consoli- has also experienced major merger waves, leading dated entity is more valuable than the aggregate of to the creation of very large banks and financial two separate pre merger banks (Pilloff, 1996). institutions. M&A’s in the banking sector evokes M&A announcement, being an important piece of high interest simply for the fact that after decades of information for any company, should normally re- strict regulations, easing of the ownership and con- sult in significant impact on share prices. Such an trol regulations has led to a wave of M&A’s in impact may be reflected in positive abnormal re- banking industry throughout the world (Focarelli, turns for the bidder banks, on merger announce- 2003). The main motivations for this unprecedented ment, if market perceives positive gains from the wave of consolidation in the financial sector are merger. Such announcement may also impact other common to most countries. In response to funda- stock characteristics such as volatility and liquidity mental changes in regulation and technology, finan- of the stock. cial institutions have attempted to improve their efficiency and attract new customers by increasing This paper examines the impact of merger an- their geographical reach and the range of products nouncements in Indian banking sector on stock they offer. The desire to preserve falling margins by returns, volatility and liquidity of the bidder banks. increasing market share and attracting new custom- Market reaction to merger announcement in devel- ers is often fulfilled by way of M&A’s that allow oping countries may be quite different and distinct financial institutions to increase rapidly their size from that of in case of developed countries due to and to improve their knowledge of new products the existence of different regulatory framework. and markets. Furthermore, mergers help financial Mergers in developing countries, like India have not institutions diversify their portfolios or increase necessarily been market driven but have taken place their market share (Amel et al., 2004). Mergers at the initiative of regulator too. In such a situation, have the potentials of possible value creation for where mergers are taking place in the Banking sec- various stakeholders. For example, shareholders in tor with a variety of considerations, including policy initiatives, it is interesting to understand how mar- kets in developing countries react to merger an- Muneesh Kumar, Shalini Kumar, Florent Deisting, 2013. nouncement and in turn impact shareholders’ value. 127 Banks and Bank Systems, Volume 8, Issue 1, 2013 1. Prior research in their study of mergers in European banking mar- kets, Cybo-Ottone and Murgia (2000) find positive The underlying rationale for consolidation of banks and significant gains in shareholder’s value of bid- has focused primarily on the achievement of effi- der banks and Campa and Hernando (2006) also ciency improvements through cost reductions report positive returns to shareholders of target (Campa and Hernando, 2006). Bank mergers can banks and zero returns to bidder banks. Scholtens increase value by reducing cost and/or increasing and Wit (2004) examines the short-term wealth revenues (Houston, 2001). It may also reduce indus- effects of bank mergers in the US and European try risks through the elimination of weak banks and market to both the target and bidder banks share- create better diversification opportunities. However, holders. The study finds that there are significant consolidation could increase bank’s propensity to differences in the shareholder wealth effects of US. take risk through increases in leverage and off- and European bank mergers but there are situations balance sheet operations. Furlong (1994) stated that in which market reactions do not significantly dif- an early view of consolidation in banking was that it fer. Both targets and bidders show positive cumula- made banking more cost efficient because larger tive abnormal returns in Europe whereas in the U.S. banks could eliminate excess capacity in areas like only target show positive abnormal returns. The data processing, marketing or overlapping branch overall value of bank mergers is positive in Europe networks. Cost efficiency also could increase if and neutral in the US. Gayle de Long (2003) uses more efficient banks acquired less efficient ones. event study methodology to find out if bank mer- However, empirical evidence does not offer conclu- gers create value. The results indicate that although sive support to this contention, as Akhavein et al. market reacts positively upon announcement of (1997) find little change in cost efficiency but an mergers that focus activities, geography and part- improvement in profit efficiency of large US banks ner’s earning stream, focusing mergers do not nec- after M&A’s, especially if both merger participants essarily produce long-term benefits. Another inter- were relatively inefficient prior to the merger. On esting study is made by Annalisa Caruso and Fabri- the other hand, Hughes and Mester (1997) provide zio Palmucci which conducts an event study on evidence to suggest that there are scale economies Italian banks and is of the view that choosing an- in banking. Rhoades (1996) reported that American nouncement date as the event date may only give banks consolidated in response to the removal of partial reactions of the market because of leakage of restrictions on bank branching across states, indicat- information. Among the few event studies on the ing that regulatory impediments to organic growth Italian market, Ferretti (2000) finds a negative mar- could also drive M&A. Harada & Takatoshi (2011) ket reaction for bidders, while Resti and Siciliano examines short and long-term performances of con- (1999) find significant gains for the target banks. solidation of larger scale banks. Likewise, the ex- Thus, the empirical evidence suggests that commer- amination of M&A’s in European banking found cial banks M&A’s do not significantly improve cost that industry consolidation was beneficial (by pro- and profit efficiency and, on average, do not gener- viding social benefits) in the first economic integra- ate significant shareholder value. There is evidence tion stages, but could damage welfare in the more in favor of exploiting scale economies, but only up advanced stages as few big banks safeguard price to a size well below that of the most recent large agreements to forestall foreign competition (So- deals. Economies of scope are harder to pin down; moye, 2008). The possible impact of merger on there is no clear-cut evidence of their existence performance of bidder bank and the premium to be (Amel et al., 2004).